How durable is the shift to remote work? And how pronounced is the impact of that shift likely to be on office vacancies in the US?
The first question is hard to answer, which means the second one is too, but Goldman made a run at both in a note dated August 28.
Having tasted remote work, workers aren’t necessarily keen to return to the office, or at least not five days per week. Given the still large mismatch between the demand for labor and the supply of it, many employers have little choice but to acquiesce.
“The share of remote job openings increased rapidly with the onset of the pandemic and is now above 10%, roughly 2.5 times its pre-pandemic level,” analysts led by Jan Hatzius wrote. Their analysis of state-level data suggests every 1pp increase in the jobs-workers gap translates to a 0.3pp increase in remote work job postings.
A corollary is that remote work opportunities should decrease as job openings fall, which they did in July according to the latest JOLTS data, released on Tuesday. But Goldman suggested companies’ propensity to offer remote work will only decline “modestly” as the labor market normalizes.
Remote work jobs currently account for around 11.5% of open positions. Hatzius and his team only see that declining to 10.8% over the next three years. That figure was around 4% pre-pandemic.
Needless to say, the rising share of remote work leads directly to lower office utilization. The transmission mechanism is simple: If you’re at home, you’re not in the office.
If you extrapolate from access swipe data in 10 major US cities, you’re left to conclude that average office utilization is still down by about 50% (see the dark blue line in the figure on the left, below).
And yet, there’s been no commensurate decline in commercial tenant occupancy rates. Why? Well, because the leases aren’t up yet.
Data current as of this month shows less than a fifth of office leases are up by the end of next year, and less than a third expire over the next two years. 35% don’t expire until after 2030. “The lock-in effect of long lease duration limits firms’ ability to adjust office demand in the near-term,” Goldman remarked.
But it’s not just that. You also have to come up with an estimate for elasticity. So, how sensitive is office demand to the growing prevalence of work-from-home arrangements? One estimate cited by Goldman suggests a 10% increase in remote work translates to a 5% decrease in demand for office space when it’s time to renew leases.
Putting it all together, and folding in the bank’s estimates for labor market normalization, Goldman reckoned remote work may put around 0.8pp of upward pressure on office vacancy rates over the next two years, another 2pp (at least) from 2025 through the end of the decade, and roughly another 2pp after that.
As Hatzius wrote, “This is equivalent to an increase in vacant office space by 46 million sqft at the end of 2024, an additional 125 million sqft over 2025-2029, and another 96 million sqft in 2030 and beyond.” He called that “a sizable impact” when juxtaposed with the roughly 50 million sqft of new office construction completed last year.
Fortunately, the impact on GDP (via the crowding out effect for new office construction) is expected to be minimal in the near- to medium-term, at just 0.03pp next year and in 2025.
I’ve been wondering about this topic, thanks H. On the surface, to me at least,it seems like a much larger problem than Goldman figures. I thought office vacancy rates were through the roof, and I can’t believe more office space was completed last year.
I can’t understand this either but anecdotally in the KC market I have seen a number of sizeable new office properties being added to the stock and immediately filled. Some of our large suburban spaces have changed occupants, but remain filled. Overall, it seems there has been a net addition of space here. We are not NY but property development is still moving along. Since COVID residential space has been booming with thousands of new rental and SF units added in large mixed projects.
I cannot give you attributions and names because we were given this info from a client. He runs a large property investment fund.
Because of his heft in the market he was invited to join an advisory board to one of the largest private investment companies, whose name most of you would know.
A few months ago folks on the board were told that they were preparing to mark down the valuations of their office holdings by 40%. No, not 4%. 40%.
When I return to work, I’ll have to check in with him. Over the years his observations have proven to be prescient.
While it would take a bit of work, particularly with reworking the plumbing, making some of that space “residential” probably would be a benefit and dare I say it – disinflationary.
Office-to-residential conversion for post-war buildings is very expensive and takes a long time (not just permitting/construction, ownership also needs to tumble down to a party desperate enough, with a cost basis low enough, for a large upfront investment followed by residential rents to be tolerable). The resulting units are unlikely to be disinflationary.
Pre-war buildings (smaller floorplates, openable windows, etc) are easier to convert. NYC did a big O-to-R conversion push a few decades ago and almost all the residential units produced were in pre-war buildings.
At least in my area, I think we’ll see office users migrate to better buildings at lower rents, leaving the Class C buildings vacant and defaulted. Those that can be converted to residential will be (hopefully saving a lot of nice pre-war structures), others will be zombie buildings until the next wave of development brings the demolition crews.
In my city, housing advocates dream of mass-converting office and mall buildings to affordable housing, homeless shelters, etc. They need to spend some quality time with a spreadsheet pro forma.